FCA Says New Regs May Address Its Limits To Stop Harm Caused By Third Parties

July 22, 2022
In its latest perimeter report, the UK Financial Conduct Authority (FCA) highlights potential gaps where it lacks the power to step in and the actions the authority is taking to reduce harm linked to these gaps.

In its latest perimeter report, the UK Financial Conduct Authority (FCA) highlights potential gaps where it lacks the power to step in and the actions the authority is taking to reduce harm linked to these gaps.

The FCA has said there are a number of unregulated firms, such as cloud service providers, buy now, pay later (BNPL) firms and certain crypto companies, where its powers are “extremely limited” when they carry out activities that are not regulated.

For example, businesses are increasingly relying on unregulated third-party providers to deliver services vital to the financial system.

These third-party firms such as cloud service providers are not regulated by the FCA and could pose systemic risks to the UK financial sector, according to the FCA.

“Where many firms rely on the same third party, such as cloud service providers, the potential harm if these providers fail increases. This can present potential systemic risks to the UK financial sector, such as wide reaching harm to consumers and threatening financial stability,” the report says.

In the last three years, third-party failure has been at the top of the list of root causes of the operational incidents reported to the agency, with almost one-quarter (23 percent) of the incidents citing third-party failure.

“This raises questions around whether the financial services regulators have sufficient regulatory oversight of these services to manage the ‘concentration risk’,” the regulator adds.

This issue was highlighted earlier this month in Canada when a nationwide failure at telecoms provider Rogers brought down large parts of the country to a standstill, including domestic card system and electronic transfers system Interac.

Although current guidance makes it clear that regulated firms are responsible for identifying and managing their third-party risks, the regulator said “we recognise the limitations of the current regulatory framework in managing these potential systemic risks”.

The upcoming Financial Services and Markets Bill may change the FCA’s regulatory perimeter in this regard and the regulator said it will take further steps to address these systemic risks once the bill receives royal assent.

Increasingly popular BNPL products also fall outside the current regulatory regime.

To address potential harms, HM Treasury carried out a consultation on potential options to change the scope and form of regulation. It published its response to the consultation last month, confirming its intention to consult on the draft secondary legislation toward the end of the year

In the meantime, the FCA assured that “where we see harm, we will act using our existing powers and our non-FSMA [Financial Services and Markets Act] consumer protection powers, which can apply to unauthorised firms where we see poor practices”.

Although the agency’s powers are limited against unregulated firms, the FCA can use general consumer protection legislation against them if a consumer contract is likely to be unfair or insufficiently transparent.

For example, in February, the UK’s largest BNPL providers Clearpay, Klarna, Laybuy and Openpay agreed to change their contract terms to address the FCA’s concerns about potential risks of harm to consumers.

The authority has also reiterated its concerns regarding its powers over crypto firms.

Most of these firms are not authorised under the Financial Services and Markets Act 2000 (FSMA) but are supervised by the FCA under the Money Laundering Regulations (MLRs).

The regulator said it is now working closely with the Treasury and other relevant regulators to extend the scope of the FSMA (Financial Promotions) Order 2005 (FPO) to some unregulated crypto-assets.

“In the meantime, as future legislation is considered and as the use of crypto-assets and its underlying technology develops, we will continue to monitor the market and consider whether activities fall within our perimeter.

“We will continue to act where we see harm and where we have the powers to do so,” it stressed.

In addition, the perimeter report reveals that the FCA is considering the broadening of open banking to open finance.

“We are working closely with the Department for Business, Energy and Industrial Strategy (BEIS) and the Treasury on this, to consider how to deliver open data in financial services (open finance), following the Queen’s Speech announcing smart data legislation.”

According to the regulator, open finance has the potential to transform the way consumers and businesses use financial services and it “requires a range of considerations, including the lessons we can learn from open banking, assessing the required regulatory framework, considering the open finance initiatives in other countries and working closely with industry as industry initiatives accelerate”.

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